As stock prices continue their recent sharp fluctuations, mostly to the downside, we are writing again with more information (research from Guggenheim Investments), to present a long term perspective.
From year-end 1945 to year-end 2017, covering 72 years and using the S&P 500 index (note: S&P 500 index and Dow Industrial average often have similar percentage price changes), there have been:
- 77 declines (approximately once a year) of 5-10%, with an average decline of 6%, covering one month and taking one month for the declines to recover to the price level at the start of the decline;
- 27 declines (approximately once every two to three years) of 10-20%, with an average of 14%, covering four months, with four months for the declines to be recovered;
- 8 declines (approximately once every nine years) of 20-40%, with an average of 27%, covering eleven months, with fourteen months for the declines to be recovered;
- 3 declines (approximately once every twenty four years) of more than 40%, with an average of 51%, covering twenty-two months, with fifty-seven months for the declines to be recovered.
The current decline on the S&P 500 (to 2,581 as of the close on February 8th) has now reached 10.2% from its January 26th all-time high of 2,873 (the Dow Industrials have gone from a January 26th high of 26,617 to a February 8th close of 23,860, a decline of 10.4%). Which of the above categories the current decline will eventually fall in is as yet unknown, and this represents the risk associated with stock investing.
The media and financial pundits try to attribute reasons for the declines, such as: (A) an economy that is doing so well that it may cause the Fed to raise interest rates to a level that negatively affects stock prices (see our January 2018 Comments for more on this subject), or (B) traders using highly leveraged products based on volatility, or (C) some other rationale designed to fit the event after the fact.
But perhaps the reason for these declines is simply that stock prices had gotten too high.
To elaborate, the last significant decline before this one (Jan-Feb 2016) reached 11%, and was followed by two years of extraordinary gains. At the January 26th, 2018 high, the S&P 500 index had advanced from 1,829 to 2,873, a gain of 57% (the Dow rose from 15,660 to 26,617, a gain of 70%).
Finally, note the impact of asset allocation: for younger clients not currently using their money, an allocation of 70% to stocks means 30% is not affected by the stock declines, and for older clients who might currently be using their money, a 35% stock allocation means 65% is not affected by the declines. An important part of our work at Park Piedmont Advisors is to develop and follow allocations designed specifically for each of our clients.